Early Market Thoughts

Blood on the streets to kick off another busy week in the markets. The Fed looms as the major story for markets. We have seen faith in the Fed’s ability to battle inflation wane. This has knocked markets off a potential basing pattern that started to form and lead to a fresh round of selling.

Fed Chair Jerome Powell will do his best to reassert the Fed’s capabilities. The Fed’s ability to reclaim the narrative is the key story for us to watch this week.

In addition to the Fed, we will see a slew of economic data on inflation and sentiment. We also have another busy round of sell-side conferences. We should expect several red flags from both areas.

Look for companies and analysts to establish new earnings expectations ahead of the Q2 earnings season. This will lead to valuation adjustments (which the stock market is already implementing). How stocks react to warnings and target cuts will be a key read for investors.

Another interesting aspect for this week is that we have options expiration. One phenomenon we have seen around the past two VIX expiration is a rally on the Tuesday prior to the Wednesday expire. The mechanics involved in the expiration include the need for dealers to buy SPX options.

We will not get too deep into the weeds on this price action but we want to highlight the possibility and urge caution about reading too deeply into any pre-Fed rally as the gains could be fleeting.

The bottom line is to remain cautious, trade in smaller size, and start making your shopping list of names you want to own. That is the goal for this week.

Recap of Last Week

It was another brutal week for equities. The Nasdaq led the way lower, falling -5.6% for the week. The S&P slipped -5.1% to 3,901. This marked the ninth time in the last ten weeks that these indices ended in the red. The Dow fell -4.6% to 31,393, marking its tenth loss in the last eleven weeks. The markets have not seen a string of losses like this since the Great Depression.

The motto “You can’t fight the Fed” continues to reign supreme.

The trading action started off innocently enough. Indices traded in a tight range for the first four sessions. Support and resistance levels held firm as investors anxiously awaited news from the European Central Bank and the Consumer Prices reports.

The consolidating pattern broke down Thursday afternoon. Equities started seeing pressure following the ECB press conference as President Christine Lagarde failed to ease market worries around inflation. Market participants started selling around lunchtime as fears around the Friday print mounted. The selling momentum would continue into the Friday release.

Once the numbers crossed, investors headed for the hills. The Dow shed 880 points to fall 2.7%, the S&P declined 2.9% and the Nasdaq sank 3.5%. The sell-off was broad based as we saw declining stocks outpace advancing by a 5-to-1 ratio.  For the week, decliners outpaced advancers 8-to-1.

The carnage has continued into the Monday morning session. It will be difficult for the buyers to step in ahead of the Fed meeting but we would keep an eye out for a potential bounce on Tuesday as we prepare for options expiration in volatility.

This flush is a necessary evil and part of the bear market process. Allow it to continue and do not feel the need to be aggressive. 

Key Support/Resistance Levels:

As a reminder, the futures contracts roll over from June (M) to September (U) this week. The levels provided will be given in terms of the September contract.

  • S&P 500 (ES)
    • Resistance– The 3900 level marks the lows from Friday. This would be the first hurdle for bulls to push through to repair last week’s carnage.
    • Support– We are testing the May lows (3807) to kick off the week. A break below starts to pull in the 3500-3600 area which is where we broke out way back in February of 2021.
  • Nasdaq (NQ)
    • Resistance– The Friday lows lie around the 11,800 area. This level through 12,00 promises to offer heavy resistance for bulls to try to fight through. It will be extremely difficult with the Fed on tap.
    • Support– 11,400 marks the May lows. If this is breached, then we could be looking at a test of the 50-monthly moving average which sits approximately 1,000 points lower around the 10,500 level.
  • Dow (YM)
    • Resistance– 31,300 marks the Friday lows for this index. That is the first obstacle investors will need to recover before thinking of pushing higher.
    • Support– There is a lot of support below for the Dow. The 30K psychological level is first in line. If that is breached, then we have the 200-weekly (29,261) and the 50-monthly (28,900).

Four Stories to Watch

The Fed:  The central bank is expected to raise rates by 50 basis points on Wednesday. This will mark the first time since 1994 (Mexican Peso Crisis) officials have lifted rates by more than the standard quarter-point multiple.  The FOMC will provide an update to its Summary of Economic Projections (SEP) which includes GDP, inflation, and the Fed Funds rate. The committee will provide its latest Dot Plot as investors try to predict where the rate tightening cycle will end. Fed Chair Jerome Powell will hold a press conference at 2:30pm ET to discuss the materials and the Fed outlook. This is far and away the most important event for the markets this week.

Inflation: The hot CPI report rattled markets on Friday. The University of Michigan Consumer survey added to the consternation as the inflation segment of the survey hit an all-time low. We will get a few more data points this week to help round out the story. The May PPI numbers are released Tuesday at 8:30am. On Wednesday, the May Import and Export Prices will be revealed.  These numbers will not change the narrative, but they will provide some volatility for traders.

CME Fed Funds Futures: We will need to keep an eye on the CME countdown for the market expectations and match them up to the Powell commentary. Here are the current CME projections. The first number is where they stood before the CPI number was released. The second figure is where market expectations sit as of this morning. As we can see, most think the Fed has a lot of work to do to contain inflation.

  • June– 96% chance for 50 bps… Now 75% for 2, 25% for 3 (125-150- 2 hikes)
  • July– 72% chance for 50 bps (175-200- 4 hikes); 26% chance for 75 bps (200-225- 5 hikes)… Now 31% and 67%, respectively.
  • September– 62% chance for 50 bps (225-250- 6 hikes); 21% chance for 75 bps (250-275- 6 hikes)… Now 23% for 225-250, 76% for 250-275+.
    • This is when the Fed would hit its Neutral (2.4%) level.
  • November– 52% chance for 25 bps (250-275); 31% chance for 50 bps (275-300- 7 hikes)… Now 8% for 250-275, 31% 275-300, 60% 300-325+ (8 hikes).
  • December– 41% chance of 25 bps (275-300); 37% chance for 50 bps (300-325- 8 hikes)… Now 22% for 300-325, 36% for 325-350 (9 hikes), 41% 350-375+.
    • This sets the year-end target for the Fed around the 3.25% area.

Sell-side Conference: Another buys week on the sell-side conference front. Some of the key ones for us to watch include Goldman’s Global Healthcare, Bank of America’s Global Defense, Morgan Stanley’s Financial Payments, the Oppenheimer e-Commerce conference, and Deutsche Bank’s Global Auto. We are fresh off a series of warnings from the retail sector. Markets will be closely watching the space for updates at the Oppenheimer conference. Investors will be closely watching comments from the MS FinTech as there have been rising concerns around the BNPL platform and credit. That could be the next leg to drop in this market.

Four Stocks to Watch

  • Oracle (ORCL)– It is a very slow week on the earnings front but ORCL certainly stands out as a key May-end quarter and bellwether. The report will provide the latest update on enterprise spend. Analysts expect a solid print from the report with the street modeling approximately 7% growth for the quarter. FX looms as a headwind for the company. Updates on the Cerner acquisition are expected. The stock slipped below key support at $65 in this broad market sell-off. The 200-weekly ($63) sits just below.
  • Kroger (KR)- The company reports earnings Thursday before the market opens. The grocery store chain will be closely watched as consumer spending habits are altered by inflationary pressures. Retailers have been cautious in their guidance so any ability to reaffirm current outlooks would be viewed as a positive. Shares of KR have held up relatively well in this market with the stock chopping around the $50-psyche level for the past three weeks. There is ample support at the $46-48 area. If the print is poor and the stock holds then we should be looking at this as a potential buy.
  • KLA Corporation (KLAC)– The semiconductor equipment company holds its Investor Day on Thursday. Given the macro uncertainty, it will be interesting to see how the company frames the WFE market growth over the next few years. Comments around the supply chain will be closely monitored. Deutsche Bank expects the company to reaffirm Q4 outlook and provide an update on its 3-year financial targets. The stock sits precipitously on support at $320. It will be paramount to hold this level otherwise shares could succumb to aggressive downward selling pressure.
  • Bitcoin (GBTC, BITO, ETHE)– There is some carnage in the bitcoin sector. We are now seeing some issues with Binance that will raise further concerns around cryptocurrencies. Bitcoin futures have broken below major support levels (28K) which has led to sellers rushing for the exits. The next major level for support in Bitcoin futures is not until the 21K area which is the 200-monthly, a major trend line. We need to monitor these names as a measure of sentiment. Watch Ethereum (ETHE) as it is expected to make some news this week with a shift from energy-intensive proof-of-work methods for securing the network to a proof-of-stake model with lower transaction costs. I doubt this will offset the selling pressure but we should keep an eye out on this story and any reactions.